Balance Sheet Lets Fed be Patient on When to Reduce QE

The Federal Reserve can afford to be patient in deciding when to begin scaling back its bond purchases because there will be little difference to the size of the Fed's balance sheet whether the U.S. central bank starts to taper in December or waits until April, a top Fed official said.

In a familiar speech defending accommodative monetary policies, Eric Rosengren, president of the Boston Fed, said it may be appropriate to reduce the quantitative easing program when there is "compelling evidence of a sustainable recovery making satisfactory progress toward full employment."

The Fed's monthly purchases of $85 billion in Treasurys and mortgage-backed securities are meant to hold down long-term interest rates and stimulate U.S. investment, hiring and economic growth in the wake of the Great Recession.

Given a gradual drop in unemployment and worries over a swelling Fed balance sheet, now at a record $3.8 trillion, investors were shocked when policymakers chose not to reduce the bond purchases in September. The policymakers again stood pat last month, leaving investors guessing when they will finally move.

Rosengren, a policy dove who strongly backed the decisions, highlighted data comparing two "hypothetical" approaches to quantitative easing: one in which the buying is unchanged until April 2014; and another fairly aggressive approach in which the buying is reduced to $75 billion in December, $50 billion in January, $25 billion in March, and completed altogether by April.

"Start dates differing by a quarter or two would generate only relatively small changes in the overall size of the Fed's balance sheet," Rosengren said in remarks prepared for delivery at the University of Massachusetts Boston.

"That is certainly one reason for being patient, waiting until evidence of a more sustainable recovery is more clear-cut, before beginning any reduction in the size of the purchase program."

To give even more support to the lackluster economic recovery, the Fed has stressed that irrespective of quantitative easing, it will keep interest rates near zero at least until unemployment falls to 6.5 percent, as long as inflation remains contained.

U.S. unemployment was 7.2 percent in September, down from 7.8 percent a year ago. Gross domestic product growth has averaged 2.2 percent since the recession ended in 2009.

When the bond-buying is ultimately reduced, Rosengren said, rates will need to stay at "very low levels until there is much more progress reaching full employment," of 5.25 percent joblessness in his view. At that point the pace at which rates are raised should be "quite gradual unless the economy picks up much faster than is currently expected," he said.

"While the economy has been gradually improving, it is not yet time to celebrate our economic performance," Rosengren added.